TY - JOUR
T1 - Equal treatment under the Fed
T2 - Interest on reserves, the federal funds rate, and the ‘Third Regime’ of bank behavior
AU - Dutkowsky, Donald H.
AU - VanHoose, David D.
N1 - Publisher Copyright:
© 2019 Elsevier Inc.
PY - 2020/1/1
Y1 - 2020/1/1
N2 - Since the latter part of 2018, the federal funds rate has been equal to or nearly equal to the interest rate on excess reserves (IOER). Correspondingly, the Fed has expressed a desire for increased interbank lending within its target range for the federal funds rate. This paper examines these developments within a model of bank behavior. We argue that the resulting spread between the federal funds rate and IOER during this time led banks to switch to a third regime, different from the zero-excess-reserves regime of pre-October 2008 or the zero-wholesale-loan regime of post-October 2008 up to the period described above. Comparative-statics results from general-equilibrium solutions show that within this third regime, in which banks choose positive quantities of excess reserves and wholesale loans, banks exhibit the strongest response in retail lending to changes in the federal funds rate and the IOER. This regime, though, also has the weakest response in retail lending to a quantitative easing-type policy. Extending the model to the interbank loan market reveals that in the interior solution regime, even when faced with large increases in exogenous loan demand, banks borrow from the interbank loan market only under restrictive conditions. Taken with previous findings, we argue that monetary policy can include the Fed choosing the federal funds rate-IOER spread to determine the regime within which it desires for banks to operate. In this regard, we offer a sketch of how the Fed can utilize monetary policy strategically to stabilize the macroeconomy during the next recession.
AB - Since the latter part of 2018, the federal funds rate has been equal to or nearly equal to the interest rate on excess reserves (IOER). Correspondingly, the Fed has expressed a desire for increased interbank lending within its target range for the federal funds rate. This paper examines these developments within a model of bank behavior. We argue that the resulting spread between the federal funds rate and IOER during this time led banks to switch to a third regime, different from the zero-excess-reserves regime of pre-October 2008 or the zero-wholesale-loan regime of post-October 2008 up to the period described above. Comparative-statics results from general-equilibrium solutions show that within this third regime, in which banks choose positive quantities of excess reserves and wholesale loans, banks exhibit the strongest response in retail lending to changes in the federal funds rate and the IOER. This regime, though, also has the weakest response in retail lending to a quantitative easing-type policy. Extending the model to the interbank loan market reveals that in the interior solution regime, even when faced with large increases in exogenous loan demand, banks borrow from the interbank loan market only under restrictive conditions. Taken with previous findings, we argue that monetary policy can include the Fed choosing the federal funds rate-IOER spread to determine the regime within which it desires for banks to operate. In this regard, we offer a sketch of how the Fed can utilize monetary policy strategically to stabilize the macroeconomy during the next recession.
KW - Bank credit
KW - Federal funds rate
KW - Interest on reserves
KW - Monetary policy
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U2 - 10.1016/j.jeconbus.2019.105860
DO - 10.1016/j.jeconbus.2019.105860
M3 - Article
AN - SCOPUS:85071446661
SN - 0148-6195
VL - 107
JO - Journal of Economics and Business
JF - Journal of Economics and Business
M1 - 105860
ER -